The Cone of Uncertainty and How it Impacts Your Personal Spending Plan
Tue, Sep 1, 2009
Estimating your budget is no easy task. The budget, after all, is your monthly spending plan or what I like to sometimes consider a monthly project plan to staying on track towards your goals.
Uncertainty in your personal spending plan
As a project manager, I know that when you start a new project there is some uncertainty in the beginning as to the level of effort, or actual work and the duration, or time the project will take to complete. This is commonly referred to as the cone of uncertainty. The further you get into the project; work required and duration become clearer. The cone becomes narrower. And at the completion of the project you know exactly the level of effort and time it took to complete the project.
I think the same principle can hold true for budgeting. At the beginning of the year, there is some amount of uncertainty as to how much money you will spend for the year. Some expenses are easier to estimate than others. For example, you know how much your mortgage is going to be for the entire year unless you refinance or sell your home.
The cone of uncertainty is much larger at the beginning of the year for expenses such as gifts you need to buy, gasoline, etc. As with projects, the expenses are only absolutely known when they occur. But, to manage money wisely, we have to have some baseline estimate to plan for these expenses.
Reestimate personal spending plan
To manage the uncertainty in projects, the project has to be estimated again at certain points along the way in order to properly manage expectations with stakeholders and determine if you’re on track. The same is true with a budget or spending plan.
It’s a good approach to create a plan at the beginning of the year based on what you expect to spend for fixed and variable expenses. You can use last year’s variable expenses averaged across 12 months to come up with an initial amount for each expense. And to build a safer margin to minimize underestimation, you could use the 12 months average plus a 10 – 20% contingency.
Now as with projects the spending plan needs to be estimated again. I’ve found the best time to estimate again is before the next month begins. By revisiting your plan 12 times throughout the year you will become a much more accurate estimator of your expenses. Close tracking and cash flow management throughout the month with personal finance software or a good expense tracking form will also help.
Advantages of creating a monthly spending plan
The advantage to creating a new spending plan every month or estimating the previous month’s plan again, is you get an opportunity to reallocate spending to meaningful goals versus spending it. For instance, if you were to have an extra $100 in your budget for the month because current expenses for the month were lower, you might not notice unless you were paying attention. This money, as you probably know, quickly disappears. In other words, you’ll always find a need for it unless you’re conscious of it.
As the plan is estimated again for the next month, the surplus can be easily identified before the month and a purpose for the surplus can be found beforehand. You are now conscious of the money, know its purpose and can put it to use versus letting it dwindle away.
I think the key to managing a good spending plan is managing the cone of uncertainty. Narrow the cone by estimating your budget each month and perform good expenses tracking and cash flow management throughout the month. Such actions lead to paying off debt, building an emergency savings fund, and saving for some of the fun things in life too.
How often do you plan your spending and manage the cone of uncertainty?
Picture by David Trowbridge.
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Tags: Budgeting & Spending, Estimate Expenses, Spending Plan
Interesting – I’d never heard of the “cone of uncertainty” before.
I treat each month’s budget as it’s own “project”. Any excess is handled by using a ‘sweep’ account. For my household budget, this is the utilities account, for personal spending budget, it’s gasoline. These are my most variable accounts, so any excess in other categories dumps into them. Last month’s ending balance becomes this month’s beginning balance.
So by midway though the year, the sweep account has a fairly large ‘cushion’. That made last year’s high energy prices frustrating, but not devestating. I do have a max limit on the sweep accounts. If I hit that, some of the excess is siphoned off to investments.
Threadbndr,
Thanks for sharing. I applaud your discipline in avoiding spending the excess and that you are concious about the purpose for this surplus, when it occurs. Keep up the good work!